Without revealing exactly which areas we're scouring (we're open to all of them), I can share one important lesson on assessing consumer investments, one that we have learned the hard way--from either bad investments or regret from passing on good deals. The lesson is that venture capitalists don't have a clue how consumers will behave.

As conceded in our anti-portfolio, I passed on the Series A round of eBay because I couldn't imagine a big business based on selling stamps, old comic books, and used junk. But I did invest in EXP, an internet exchange selling all kinds of advice (legal, technical, household, business...). Both mistakes exemplify the egotistical VC tendency (at least mine anyway).

Of course, we're not the only ones. According to a great essay in MIT Sloan Management Review, "It may soon no longer be possible for even gifted visionaries to imagine the next killer app."

Fortunately for us, user adoption is only one of the key milestones reached by a successful consumer venture. Others include a validated revenue model, a validated distribution strategy, and an IPO-quality management team. Those other milestones are ones that we can more reliably predict and control. And so, as Bessemer assesses consumer ventures, we are least interested in funding User Behavior risk, but much more comfortable with risks associated with the revenue model, distribution model, and team.

That's why my partner Rob Stavis funded Skype when it was only 3 months old with no revenue (and no idea yet of how to generate it). Having observed 2 million people download the alpha client in the first month and 150,000 concurrent users, we didn't have to worry about User Behavior risk. Clearly Skype had developed something of great value to users. The same pattern applied to Gracenote, Bokee and Blue Nile when we funded them--each had millions of registered users who found their way to the site without expensive marketing to acquire them. Had we developed this screen earlier, we would have funded eBay based on the strong, organic growth they were seeing in traffic finding its way to their homegrown site. Today, this kind of thinking reflects very favorably on the new crop of "web 2.0" services, whose viral nature and network effects can attract growing clusters of users.

The focus on "eyeballs" sounds like 1990's bubble investing, but the difference is that bubble investors valued eyeballs no matter how expensively they were acquired (since capital was free). We are looking for organic growth--the kind that's easy even bubble-scarred for VC's to mentally extrapolate into a large capital-efficient business.

That's why we believe that the formula for any successful consumer venture is to be as scrappy as possible until you see that exponential growth curve. Twist, tweak and test until you find the mark. Only then is it time to raise lots of money, hire expensive VP's, and "monetize" your users. (Be sure to read this excellent post from Brad Feld on finding the next killer app.) If Google taught the world anything, it's that you start with the customer experience, and then build the business only after you've got that one nailed.

4 comments:

I agree with your observations when it comes to eBay, Yahoo, etc, but what about social networking sites? While they may attract a fair number of eyeballs with minimal marketing $$, it isn't clear how they would make money. I would like to hear your thoughts about that.

Anonymous:It depends. You have to look at each application to find the opportunities. (Google, by the way, didn't know whow they were going to monetize search when they set out to build a "social search" engine based on the links that other people created.) Advertising, premium services, and mobile access usually come into play (as all 3 do in Bokee). For Skype it's SkypeOut minutes, and for Everquest it is subscription and, perhaps increasingly, virtual inventory.

Good point about Google, I did know that about their history. They went through a similar growth path as Yahoo because experienced management were brought in to build out a sustainable business model. So basically what I am hearing is that having plenty of eyeballs without necessarily a business model can still get pass first round with VCs, at least at Bessemer. Another case in point, eBay is in talks to buy Skype, another company with plenty of subscribers without a clear business model although they have introduced premium services as of late.

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